Friday, October 03, 2008

The Economic Consensus v. Politics

The consensus among economists is now clear, the best strategy for dealing with the financial crisis is to recapitalize the banks that need recapitalization. Paul Krugman, John Cochrane, Luigi Zingales, Douglas Diamond, Raghuram Rajan and many others all advocate some form of recapitalization as do Tyler Cowen and myself. Krugman would prefer a recapitalization in the form of nationalization. In my view, there is still plenty of private money to buy banks at the right price and my preferred model is the FDIC leading a speed bankruptcy procedure, as was done brilliantly with Washington Mutual (Cochrane also supports this model.) In the middle are most of the others who have a variety of good ideas to require the banks to raise equity in various ways.

The consensus policy of economists would put most of the burden of adjustment on politically powerful holders of equity and bonds.

There is also a consensus among economists that the bailout bill is not the right policy. None of the above economists, for example, is enthusiastic about the bailout. My bet is that all of us think that the bailout has a substantial likelihood of failing. The support that exists is born out of hope and fear not judgment and experience. Nevertheless, the political consensus is that a bailout is what we will get whether it is likely to work or not.